With markets at crossroads, investors eye 'special situation' funds

MONACO Hedge fund managers who seek out quick returns from company turnarounds and short-term bets on specific assets are in fashion as investors ponder their next move after long rallies in stocks and bonds.

Diverging central bank monetary policy, a rise in corporate deal-making and the potential for more market volatility have increased the appeal of nimble funds that can still make money in choppier, falling markets, said delegates at a hedge fund industry gathering this week.

"It's a special situations environment... You have to go for factors which are direction-agnostic," said Pragma Wealth Management's Nacho Morais on the sidelines of the GAIM conference in Monaco.

A so-called 'special sit' is a trading opportunity based on corporate events such as mergers and acquisitions as opposed to the underlying fundamentals of a security, and is a technique at the heart of the 'event-driven' hedge fund strategy.

Among such funds doing well in 2014 are Lombard Odier Investment Managers' 1798 U.S. Special Situations Fund, up 9.7 percent in the year to May, and Greylock Capital Management's Greylock Global Opportunity Fund (Offshore) Ltd, up 8.9 percent, data from Preqin showed.

Many managers at the event in the tiny Mediterranean principality were focused on strategies reliant on a 'bottom-up' analysis of an asset, rather than trying to profit from macroeconomic bets or following trends in financial markets.

With the U.S. and UK central banks on a path to tighter fiscal and monetary policy, in comparison with the euro zone and Japan, where further loosening is expected, some showed a growing appetite for less conventional investment positions that offer a hedge should market gyrations intensify.

That means favouring "activist" hedge funds that encourage a company to change its strategy, "distressed" funds, which buy assets trading at a sharp discount to their intrinsic value, or long-short equity funds, which can bet on stock prices falling.

Among distressed funds doing well in the year to May was U.S.-based Phoenix Investment Adviser's JLP Credit Opportunity Fund, up 7.25 percent, Preqin data showed.

Data tracker eVestment said activist strategies had their best monthly performance for 17 months in May, rising 4.46 percent, while distressed funds, which look to profit from buying cheap or "distressed" assets, rose 4.75 percent to be the best performing strategy in the year to date.

For Michael Rosenthal, who invests in hedge funds at wealth manager Signia Wealth, the scale of cash sitting on company balance sheets at a time of weak growth meant there were likely to be many more corporate deals in coming months.

"If you can't grow organically, you grow by acquisition... There are going to be more deals," he told the conference, adding that it was important to pick the right strategy to profit from this and other trends.

"It's a combination of art and science, but it's very much about being in the right strategies as well as the right managers at any given point in time," he said.

With valuations in some markets looking frothy, managers would need to work harder to find value, said Pragma's Morais: "Equities are only cheap in relation to fixed income, which are ultra expensive".

After rising 30 percent in 2013, the Standard & Poor's 500 share index is up 5.9 percent in 2014 to a record, while the VIX volatility index, gauging expectations of a sharp move in S&P 500 options, is at a level not seen since early 2007, before the onset of the financial crisis.

With U.S. Treasury and UK gilt yields likely to rise further, Morais said managers needed to be flexible: "We are one year into a large shift. For the past 30 years, the interest rate environment was for ever-declining yields.

"Now this has shifted so the train of thought of the managers needs to change."

Mark Cook of Swiss private wealth manager Octogone Gestion said he was looking for managers who have "convictions".

"A lot are overly diversified and lacking conviction, in a world where there's too much money chasing too few opportunities and where assets are expensive, on all historical metrics."

Much of the near-$3 trillion held by hedge funds globally, a record, is in large, multi-billion-dollar funds that find it hard to move in and out of big positions quickly and have poorer returns, eVestment data showed.

As a result, any correction in the stock market could leave them behind, said Cook.

"Too many managers cannot move their positions any more and don't have the stamina to get ready to short when they'll need to."

(Editing by Tom Pfeiffer)

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